Whack-A-Mole in China’s Bubbly Housing Market

It has gone out of fashion now but, not so long ago, there was a popular fairground attraction called Whack-A-Mole. Rascally moles would pop their cute little heads out of holes in the ground and your task was to use a giant rubber mallet to wallop the poor critters back from where they came. China’s bubbly housing market makes me think that this game could be ready for a comeback.

There’s a lot of talk these days of a bubble in China’s property market. Certainly there’s no shortage of super-sharp investors and analysts that have very strong (and very diverse) views—see what James Chanos, Andy Rothman, and Nouriel Roubini have to say.

The China team at the IMF is regularly asked about this. The question crops up in many different guises: Is China’s property sector going to crash? What about all those empty apartments that have no one living in them? Have you seen the remarkable and pristine ghost towns in Ordos? Isn’t all this going to end badly?

The various viewpoints certainly shift as one travels from the familiar cities of Beijing and Shanghai to witness the construction fever in the “smaller” megalopolises of China. Assessing the situation is not helped by the variety of different data sources that portend to tell the story of China’s real estate sector. In addition, vocal commentators complicate, rather than clarify, the situation by drawing on a palette of colorful anecdotes to paint a picture for the economy as a whole.

In all of this, there is one thing about which everyone agrees. A healthy property sector in China is essential for a healthy economy. Property occupies a central part of the economy with tentacles that link into both upstream and downstream sectors. Steel, cement, glass, furniture, refrigerators and automobiles are all reliant on housing.

The fortunes of Chinese real estate cannot be ignored.

So, then, what is our story on Chinese real estate? It is certainly true that China, perhaps more than anywhere, finds itself managing a potent cocktail of ingredients that fundamentally fuel property price inflation.

Domestic savings are high and, in large part, held captive by a comprehensive system of capital controls that prevents Chinese households and companies from diversifying internationally.

Yet, opportunities for investing those savings domestically are limited—the bulk of savings are held as bank deposits, earning interest that is well below the rate of inflation.

It’s cheap to buy property and hold it, waiting for the capital gains to accrue—there’s no property tax, no capital gains tax, and the real cost of financing home purchases is still very low.

Finally, housing demand in China is underpinned by some powerful drivers, including rapidly rising living standards and an ongoing process of urbanization that will persist for years to come.

All of these forces have led the real estate market in some of China’s largest cities to look decidedly bubbly.

The government has confronted these forces with a menu of measures. Such measures include limits on speculation and restrictions on purchases by non-owner occupiers, and the financial system is being protected through curbs on leverage and limits on loan-to-value ratios. These are all having a tangible effect, dampening prices and bringing down the volume of ‘frothy’ transactions while still sustaining a healthy pace of private investment and construction. It also seems that the government is getting better at calibrating these measures, in part through ongoing learning-and-doing.

Nevertheless, all of these efforts are still only treating the symptom of the problem—the pace at which house prices are going up—but the underlying impetus remains in place. Ultimately, the solution has to involve higher interest rates (on both deposits and loans), efforts to create a broader set of financial assets for the population to invest in, and a broad-based property tax that covers the majority of China’s housing stock. None of this will be politically easy and it will all take time. However, only this kind of deep-rooted change will create the environment where households view their apartments as shelter rather than as a (literal) concrete store of value.

Until then, policymakers will continue to have to periodically step back into the property market with successively tighter administrative controls, continuing to play Whack-a-Mole with China’s burgeoning property bubble.